TARP: A good deal for the taxpayer (published in November of 2010 in the SB News Press)

Much was written about how terrible it was for the government (we, the taxpayers), to “bail-out” the big banks, automakers, insurance companies, etc. While it is true that some of these businesses have yet to repay their TARP money, (some will never pay it back), the vast majority, and particularly the ones that took the lion’s share of the money, have already repaid it, (with interest).

With GM’s return to the public markets this week, and with the success of their IPO, I thought it would be interesting to review the TARP program, the investments that were made, and the returns we have received to-date.

First, a quick review of the TARP program – The Troubled Asset Relief Program, commonly referred to as TARP, was established to purchase assets and equity from financial institutions to strengthen the financial sector. It was signed into law by President Bush on October 3, 2008, and was the largest component of the government’s efforts to address the subprime mortgage crisis. It officially expired on October 3, 2010.

TARP allowed the Treasury to purchase or insure up to $700 Billion of “troubled assets,” defined as “(A) residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, that in each case was originated or issued on or before March 14, 2008, the purchase of which the Secretary determined promotes financial market stability; and (B) any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determined the purchase of which would be necessary to promote financial market stability, but only upon transmittal of such determination, in writing, to the appropriate committees of Congress.” (CBO report; dated 12/1/2008)

The TARP money was intended to improve the liquidity of these assets by purchasing them using secondary market mechanisms, thus allowing participating institutions to stabilize their balance sheets and avoid further losses. The Act required financial institutions selling assets to TARP to issue equity warrants—a type of security that entitles its holder to purchase shares in the company issuing the security for a specific price, or equity or senior debt securities, (for non-publicly listed companies) to the Treasury. In the case of warrants, the Treasury only received warrants for non-voting shares, or agreed not to vote the stock. This measure was designed to protect taxpayers by giving the Treasury the possibility of profiting through its ownership stakes in these institutions. Ideally, if the financial institutions benefited from government assistance and recovered their former strength, the government would also be able to profit from their recovery.

Originally expected to cost the U.S. Government $356 billion, the most recent final net estimate of the cost, (as of October 5, 2010), will be close to $30 billion, including expected returns from the interest in AIG. (This is significantly less than the taxpayers’ cost of the savings and loan crisis of the late 1980s. The cost of that crisis amounted to 3.2% of GDP during the Reagan/Bush era, while the GDP percentage of the current crisis’ cost is estimated at less than 1%.)

Of the $245 billion invested in U.S. banks, $192 billion, or 78% has been paid back, including $26.8 billion in income, and $4 billion in warrant proceeds, as of September 30, 2010. Although the TARP program was officially $700 billion, a maximum of $475 billion was available to Treasury to use, and of that, only $388 billion was spent. Of that $388 billion, $204 billion has been repaid to-date (as of September 30th), or 53%, including $30 billion in income (profit). (Treasury, Office of Financial Stability; TARP: Two Year Retrospective)

Many of the larger banks, such as Wells Fargo and JP Morgan, did not want any money through TARP, but were forced (by Henry Paulson) to take it. He reasoned that if only some banks took the money, they would be seen as weak, and the others strong, and this could cause runs on the weak banks. He may very well have been right, but now the banks that didn’t need, nor want, the money, are tarred with the same brush as those that did need it.

AIG is considered “on track” to pay back $51 billion from divestitures of two units and another $32 billion in securities. In March 2010, GM repaid more than $2 billion to the U.S. and Canadian governments and on April 21st GM announced the entire loan portion of the U.S. and Canadian governments’ investments had been paid back in full, with interest, for a total of $8.1 billion. This was, however, subject to contention because it was argued that the automaker simply shuffled federal bailout funds to pay back taxpayers.

“. . . if there’s one thing that has unified Democrats and Republicans, and everybody in between, it’s that we all hated the bank bailout. I hated it. You hated it. It was about as popular as a root canal. But when I ran for President, I promised I wouldn’t just do what was popular – I would do what was necessary. And if we had allowed the meltdown of the financial system, unemployment might be double what it is today. More businesses would certainly have closed. More homes would have surely been lost. So I supported the last administration’s efforts to create the financial rescue program. And when we took that program over, we made it more transparent and more accountable. And as a result, the markets are now stabilized, and we’ve recovered most of the money we spent on the banks.”

~President Obama, January 27, 2010

The GM IPO, which priced Thursday, was the second largest IPO in history, behind Visa, which came public in 2008 with a $19.7 billion raise, before the financial crisis broke. The government, which owned 61% of GM prior to the offering, was hoping to cut their stake to 33% (or less) through the deal. With the successful sale of 478 million shares at $33 per share, and the likelihood of raising even more money (reducing their stake further) through overallotments—extra shares that the bankers sponsoring the deal can sell if demand is there (which it certainly is), the government will recoup a sizable amount of their investment in GM. However, even with the overallotments, which will mean that GM could raise as much as $21.6 billion, making their IPO the largest in history, the government will have to sell their remaining shares in GM at an average price of $53 per share to break-even on their investment. The government is expected to sell their remaining shares over the next two to three years, and this gives them a reasonable chance of getting their money back (which is really our money).

The bigger picture from my perspective is that the GM IPO represents more than the repayment of some of our investment. The success of the offering underscores the confidence the investment public has in GM, and more importantly in the U.S. economy. After all, GM is as quintessentially American as you can get, and its success will depend on and represent a complete recovery for the U.S. economy.

As for the TARP program, I feel that most Americans will always consider it a bailout of the big banks that should never have happened. I truly believe that the U.S. economy and world financial system would have completely collapsed if we had allowed some of our large banks to fail. More importantly, it was highly likely that the collapse of some big banks would have had a domino effect, taking stronger banks down as well.

We will never know for sure what would have happened. The government took a stand, and if you review the hard facts, TARP was a success overall. For a cost of about $30 billion to save the U.S. economy, which is less than 3% of one year’s GDP, I can’t imagine anyone thinking this was a bad deal for the taxpayer.

History will surely look at the TARP program as a huge success, and as a turning point in an otherwise catastrophic downward spiral for the world economy. It certainly wasn’t perfect, but it worked, and sometimes we have to accept, and move on.

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